Federal student loans come with a fixed rate of interest, which remains constant till your debt is cleared. Private student loans come with fixed interest rates and variable interest rates. At the time of taking the loan, you will have to choose from one of these two options. This is no small decision to make. Variable-rate loans do carry certain risks, but they could also work to your advantage. There are several factors you will have to take into consideration before determining that a variable interest rate is worth the risk.
The Difference Between Fixed and Variable Interest Rates
When you take a loan with a fixed rate of interest, the interest rate is set at the time of allocating the loan and that rate stays the same for the life of the loan. With this type of loan you know exactly how much interest you will be paying on the money you have borrowed.
Loans with variable interest rates work differently. With this type of loan, you start with one interest rate and this rate keeps changing through the life of the loan. Depending on the market conditions and prevailing reference rates, the interest rate on your loan could fluctuate monthly, quarterly or annually. It could be on a downward trend for a few months and rise sharply without warning the next month. With so much uncertainty, the million dollar question is, is it worth even considering opting for a variable interest rate loan?
A look at the pros and cons of choosing variable-rate loans will help you decide whether they are worth the risk.
Pros & Cons of Choosing Variable-Rate Loans
At the outset, variable-rate loans typically start with lower interest rates as compared to fixed-rate loans. So even if the rates increase somewhere down the line, you still benefit from the lower starting rates. And if the rates stay the same for a few years, you will save a lot by the time you have finished paying off your loan.
The biggest downside of variable-rate loans is the unpredictability. It is almost impossible to know what the future holds in terms of interest rates. While you could get lucky and benefit from lower prevailing market rates, it could go the other way and you may end up paying more by way of interest.
Two Times When Choosing a Variable Interest Rate Is Definitely Worth the Risk
Choosing a variable interest rate loan may be to your advantage if you are planning on paying off the loan within a shorter period. With a shorter repayment period you will benefit from the lower starting interest rates and it won’t matter to you if the interest rates go up later.
The second instance when choosing a variable interest rate is worth the risk if you are looking for a loan with lower initial payments. The lower starting interest rates means you will have lower monthly payments when you start paying back your loan. This can help ease your financial situation when you are just starting out and earning a lower income.
Variable interest rate loans are not the right option for everybody. While they could help you save on interest, the decision ultimately depends on your appetite for risk.
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